The Apple/Beats Deal for Dummies

(This is part of a series called, “Will Streaming Kill the music Business For Good“) Read Part 1 for more background.)

Moses Avalon

WALL STREET IS STUMPED!

They can’t understand why Apple, one of their darlings, has broken its acquisition celibacy by purchasing of all things, a headphone/music company, Beats. In the wake of this deal an astounding thing will happen: The world’s most powerful record executive, Jimmy Iovine, is now working for music’s nemesis– a computer company. What does all this mean for the ailing business of music?

Wall Street cannot grasp the why of it because they are not music insiders. They don’t subscribe to Moses Supposes, The Lefsetz Letter, Music Tech Policy,The Trichordist or Jay Frank’s blog (who did a brilliant prediction of the Beats/Apple fallout). If they did they would understand why Apple wasted little time bidding for Beats and why Jimmy said yes without driving the hard bargain for which he is famous.

Well, I can’t speak for my contemporaries but here’s what I think:

First, it may seem like $3 billion is a lot of scratch, but for Apple it’s the change they throw in a tip jar. $3 billion is barely two years’ worth of Beats earnings. Most are wondering why Beats didn’t hold out for a larger number.

Why did Beats sell cheap? That’s the better question; not why Apple tossed a few shekels at a music company.

Why Beats Sold-Out Cheap

Universal Music owned Beats. Once called MOG, Interscope (a Universal subsidiary) purchased them a few years ago. Initially the idea was to create a seamless integration where one company would control every aspect of music from the acquisition of rights (the label) through to the sales platform (streaming). This is something that no record company has been able to do since RCA half a century ago with their Jazz radio stations and Phonograph players.

With the metamorphosis of MOG into Beats the plan seemed to be working. But Jimmy had a problem: the Federal Trade Commission. After RCA, the FTC decided that record companies should not own retail stores or radio stations because it created an unfair advantage. Now that streaming services have become a hybrid of radio and retail, the possibility of the FTC forcing Universal to sell Beats in an anti-trust fire-sale was a looming shadow.

Jimmy thought, why gamble when you can sell today and get rich(er)?

Why Apple Really Bought Beats

For over a decade Apple and the major labels have hated one another.

Labels hated Apple for forcing universal pricing–every song being the same price–and for being an enabler to the destruction of their main model: the album. Apple needed the iTunes Store to sell singles (small files) to support the ecosystem of their devices, but Apple’s music licenses came up for renewal– every three years!

At one point, it’s believed that Universal threatened to NOT renew if Apple didn’t allow variable pricing. Steve Jobs ultimately gave in because he knew that losing Universal’s catalog would be the eventual end of iTunes.

And so it was proved that Universal had ultimate power over iTunes, which meant they also had indirect power over Apple itself.

Apple has dreamed of getting out from under that thumb every day since. And although it has not been discussed in the news, insiders should know that a perpetuity license for content is what Apple is really buying today for $3.5B. Not a bunch of code they could write themselves in a weekend.

Does Apple care about the headphones? Of course. Every day they watch Beats leave their store with a 30% margin going into Iovine and Dr. Dre’s pockets. This has the analysts on CNBC focused on Apple’s intent to venture into “wearables.” Yes there’s probably some truth to this. But the simpatico of the Beats deal boils down to this:

Apple is tired of negotiating with the world’s largest record company and the world’s largest record company needed to get out of the conflicted streaming space.

Personally I think Apple got the better end of the deal and if you’re an artist on Universal you just lost a healthy amount of leverage.

The Future

This is a tough one. Jimmy doesn’t lose. And he’s going over to Apple. And he’s been right far more often than he’s been wrong. But…

He comes from a culture that notoriously does not get along with technology companies.

Will Jimmy be able to lead geeks as effectively as he did creatives? Will he be able to succeed where the geniuses at AOL failed with the Warner Music acquisition?

We will see.

To me the more interesting question than why Apple bought Beats is, Will Jimmy Iovine, the ultimate record man, be able to turn Apple Computers into Apple Music?

17 responses to “The Apple/Beats Deal for Dummies”

Wow, I’ve been watching this go rapidly from “No Way Stupid Bad Headphones No Interest In Dre Or Iovine” (rumor?) to “This Makes So Much Sense Apple Will Get Their Money Back And Absorb All Things Dre And Iovine.”

Heard another discussion, not clearly facetious, about whether “Dr. Dre” had a Ph.D.

Not surprised so much as interested in your assertion of Msr. Iovine as “world’s most powerful record executive.” I’ve got no one else I trust with that kind of reality as you, and of course I know about his amazing resume, so…

That leaves their stupidly bass-heavy product (and I’m a bass player!), already sold for way too much in Apple stores. And “children” like my own (19 and 23) who prefer Spotify. I don’t personally know anyone paying into the Beats subscription service.

Among the most interesting discussions I’ve heard since Michael Robertson and I sat at the Triton Pub at UCSD and he asked me what I thought about MPEG3 as a compression format for audio…

David Geffen ran off to make movies. Jimmy & Dre have the cash to go too.

Apple paid $1.9bn over the true value of Beats. Considering Beats was on the verge of bankruptcy, that’s not too shabby and there’s no way they could have held out for more.

Beats revenue model changed from a high-margin licensing operation fulfilled by Monster Cable to low-margin Beats-as-manufacturer in 2012. Their music streaming service is almost irrelevant financially and Apple could easily crush those numbers before the deal is finalized at the end of the year.

Of course Jimmy & Dre are both onboard with this, they cashed out of their distressed company into a much more stable one. Who wouldn’t do that?

So how does this help the music industry? It doesn’t really. Vivendi just became $495M richer with no musicians or royalties to pay. Numbers here:

I’m guessing that if you or I can get this info from Privco, so can Apple. If, as Privco’s free newsletter that reveals sensitive inside information claims– that Beats is basically a raided shell with no intellectual property or cash left over after paying Iovine and Dre– then Apple must’ve gotten their $1.9Bn over book value’s worth in the way of “granted rights.” My assertion is the perpetuity licenses for music which they needed for their products. Those would’ve cost Apple way over $1.9Bn over the next decade. Good deal for Apple.

Very interesting article, I think there may be some developments in the same arena, at a different corner of the computer coliseum, two companies have been winding through the courts to the Supreme Court of the USA, which apparently will render a decision this month. The issue is a brokerage software, a third party guantor of trade of hedge funds which a bank contends is a basic process well known since perhaps the beginning of time and trading between human beings. The adversary filed and was awarded a patent for a software environment, that the court will decide as to its validity. If the bank wins, according to wiki wiki, hundreds of thousands of software patents, perhaps the ones that high tech companies have been acquiring over decades, will be dead I. The water. If the other side prevails, at least there may be a leveling of the playing field, so from my pov, having been granite what may have been a grandfather software applications @ patent, it ought to be a win, win, win.

Prior to the deal, I had been predicting that Beats would win out in a battle between Beats, Spotify, and the other music services, for the simple reason that Jimmy and Dre have proven that they know how to sell things to people. This is why I think Apple bought Beats. It’s a bit like VHS vs BetaMax. Beats did not have to be the best music service, it just needed to be the one that the most people use. Apple can make it the best, whether actually, or just by perception. They paid a relatively small amount for a team who have proven multiple times their ability to get normal people to buy something at real scale. Other people might have better music services, but no one else has a team with the proven ability to sell at real scale. And to have a headphone business too, that throws off enough to pay for the team, and that gives you a toehold into wearables prior to the boom of that? Wonderfully tasty icing on the cake.

Thanks, this article does shed some insight as to the inner workings of this deal. I was one who was a bit taken back by the deal because I felt that Apple if they wanted to, could have created their own line of headphones and it would have been very successful too. But then when you think about it, the Beats team has proven that they know how to tap into a market and get people to buy. I thought maybe Apple needed another venue to tap into as well and it kinda made sense to me that they should pull that market into their product until I read this article. Now I feel that there is even a greater “prize” if you will, behind the scenes that may not surface until later as to why this deal was just right for Apple. This will be interesting to follow.

Hi Moses! I don’t know if anyone else noticed on those ‘beats’ headphones (not even talking about the streaming service).. I go through headphones because I use them all the time and find the best sounding ones for the money. The only way I knew how to judge one from another while it was still in the package was the freq range.. Historically, all the traditional electronics companies put the freq range right on the packaging.. (i.e., JVC, Sony, etc. etc.) But not just ‘beats’ but every ’boutique’ (for lack of a better term) does NOT. Don’t take my word for it, check it out! Ummm.. To me, this means that these ’boutique’ companies can go buy a pos headphone set, made God knows where, prolly $2.00 a piece in bulk with really crappy freq range and put it in their packaging and sell each headphone set for $50.00 plus.. without AT LEAST a freq range THERE AIN’T NO WAY IN HELL I would buy ANY of those!! I guess maybe I wasn’t the only one.. Just my two cents. 🙂 Thanks Again Moses 😀

Oh, one last thing in case I sound like an ‘old guy, get with the times’.. would any of YOU buy ANY product, no matter what it is, with a famous person’s endorsement without knowing its contents or specifications, especially nowadays when most folks’ ‘ethics’ or ‘morals’ go out the window during a bad economic period?

upon reflection after a day or so, “used car salesman” comes to mind.. Or P.T. Barnum.. You can be the greatest salesman in the world but if the product is crap, or at least be forthwith on what you’re getting for the money you’re charging, then in the long run you lose. Case in point, the subject of this article. I guess they might have thought the “showbiz” approach to selling goods/services was enough. (shrugs shoulders) :/

Very very interesting article about Apple acquisition of Beats what i have noticed here. How come a record label as universal with all the marketing they have can not sell its music themselves and needs itunes ? and how come itunes can dictate its rules about the pricing so as some people said Apple and Universal have some business together. I think all of this is pure money matters and deals matters using the music as product to attract the attention. When you say that without universal music catalog Apple is nothing what about the unsigned music that are distributed on itunes that does not count because it is more easy to use universal catalog and artists they get the marketing and advertising guaranty to promote itunes to the customers (fans). Beat business makes money and create a stream service so that is a competition for Apple right so they buy it so one entity can dominate the game of music or technology nobody can sing at the same time. Groov’With Me

I think you make a good point. To prove it I suggest you open a music service and see if you can attract millions of users without a license from the world’s biggest record company that controls 30% of the product in the market place.

Why is Iovine the most powerful record producer in the music business? he’s not the CEO of UMG, WMG, or SMG is he? Iovine got his honorary PhD after he gave USC a bunch of money but I don’t think Dre got one. How is Iovine powerful? he he was trying to grab Somme second rate singers from American Idol which none of done anything significant. I think Iovine is a lot of talk. He’s done mostly compilation albums. I would think that Clive Davis is a little more significant than Iovine.

I think apple bought Beats because it allows them to buy into the headphone market, which brings in profits to help subsidize Beats Music until they can figure out how to make that successful. Cue was over his head, Cook is oblivious as to what goes on in the music industry and this gives Apple a lot of free press to buy into the headphone market and subscription market. Whether it proves to be a good purchase may take some time. As far as the music industry hating Apple, I don’ think it’s as bad as it’s being painted. all Apple cares about is making 30% gross profit because they have to pay Akamai and other overhead a costs and they don’t net all that much. An far as pricing, the record industry :didn’t really know what to do and Jobs thought charging $.99 a song was a good starting point from a marketing standpoint. It’s a lot easier to pitch that than some other method that’s variable. Digital download was a new concept and the music industry thought to look to Apple for guidance.

If I were Apple, if I bought Beats, I wouldn’t allow Dre or Iovine as part of Apple. Iovine, maybe, but definitely not Dre. Dre has too many songs with vulgar language and he is going to present Apple with a huge liability problem if he opens his mouth and certain words he’s known for using come out. Dre barely graduated from High school as he got lousy grades, cut class and hung around gangs. He’s not Apple material for upper management, aside from him being rich and famous, he couldn’t get a job with Apple under normal circumstances with his education level. Apple doesn’t produce rap music which is all that guy really knows, he’s not an engineer that can design a product.

Since it’s not my money, I couldn’t care less, if it was, I certainly wouldn’t waste is on Beats.